Method of constructing a stock index

ABSTRACT

Computer-implemented methods of creating and maintaining stock indexes are provided. For a stock index of a particular size, a band is defined around the upper and/or lower limits of the stock index. To be added to, or dropped from, a particular stock index, the stocks must fall outside of the bands for that particular stock index size. Stock migration is controlled using a systematic stock migration process so that stocks are gradually added and deleted from an index. Stock investment style is determined in a multi-dimensional process, instead of a linear process. Furthermore, the number of stocks in the stock index need not be a fixed value, but may depend upon how many stocks meet predefined criteria at any given point in time.

CROSS-REFERENCE TO RELATED APPLICATIONS

This application is a continuation of U.S. application Ser. No.10/389,042 filed Mar. 14, 2003, which is incorporated herein byreference.

COPYRIGHT NOTICE AND AUTHORIZATION

Portions of the documentation in this patent document contain materialthat is subject to copyright protection. The copyright owner has noobjection to the facsimile reproduction by anyone of the patent documentor the patent disclosure as it appears in the Patent and TrademarkOffice file or records, but otherwise reserves all copyright rightswhatsoever.

BACKGROUND OF THE INVENTION

In 1896, Charles Dow created the Dow Jones Industrial Average,establishing the first broad measure of stock market performance and thefirst benchmark for portfolio performance. Limited by the technology ofits times, the Dow painted a skeletal picture of the U.S. stock market.It initially consisted of just 12 stocks, weighted by their prices. Asthe original index, the Dow became the yardstick for relativeperformance.

Over the ensuing century, new technologies made it possible to createindexes that more accurately captured the performance of the U.S. stockmarket: for example, the Standard & Poor's 500 Index, the Russell 3000Index, and the Wilshire 5000 Total Market Index (in ascending order ofcomprehensiveness). These indexes are weighted not by prices but by themarket value of their constituents, and thus better represent theuniverse of securities available to U.S. investors.

In the mid- to late-1970s, however, a burgeoning industry of investmentconsultants recognized that these broad market indexes wereinappropriate benchmarks for professional money managers. Most managersoversee portfolios that track not the broad market, but discrete sectorsof it—stocks of a particular size, for example, or stocks withpronounced growth or value characteristics.

The consultants addressed the mismatch between managers and benchmarksby creating indexes of stocks in various capitalization ranges and ofdifferent investment styles. Since then, the industry has createdmultiple indexes to track every sector, industry, and sub-industry. Thesame has happened with bonds. There are few sectors of the financialmarkets that are not being sliced, diced, and tortured by anever-growing list of index creators.

Despite the proliferation of indexes, these benchmarks have notprecisely reflected the way managers actually invest. On balance, theymeasure the wrong set of securities or, if not that, then the wrong wayof managing those securities. As evidence, research shows that thecorrelation between the performance of growth and value managers is muchhigher than the correlation between growth and value indexes. In otherwords, the growth and value indexes reflect a degree of difference ininvestment styles that doesn't exist in the real world. The sameproblems exist with indexes that represent other subsectors of the broadmarket.

It is indeed puzzling that two different indexes designed to provideinsight into the same sector of the market—large-cap (capitalization)value stocks, for example—can provide very different results. Thediscrepancies arise because of differences in the methodologies used tocreate the indexes. Over long periods, different value and growthindexes generally, though not always, provide similar results. In theshort run, however, their differences cause confusion and limit theirusefulness as benchmarks.

A better approach to creating and maintaining indexes that providemeaningful benchmarks for money managers is needed.

BRIEF SUMMARY OF THE INVENTION

A first embodiment of the present invention provides acomputer-implemented method of creating and maintaining a stock index.To implement the method, a stock size range is defined. The stock sizerange has an upper limit and a lower limit. A band is then definedaround at least one of the upper limit and lower limit. For stockindexes other than for large-cap stocks, there are preferably bandsdefined around the upper limit and the lower limit. Large-cap stockindexes will have a band only around the lower limit if the upper limitis the largest stock in the market. The stock index is initiallypopulated with stocks that fall within the upper limit and the lowerlimit of the size range. Periodically added to the index are stockswhich fall within the stock size range and also fall outside of theband. Stocks in the index are periodically deleted if they fall outsideof the stock size range and also fall outside of the band. The stocksize may be based on market capitalization. There may be a plurality ofconsecutively defined stock size ranges, and the lower limit of the bandof each stock size range can be made about equal to the upper limit ofthe preceding stock size range. The stocks that fall within the stocksize range are determined without regard to whether shares of the stocksfloat on the stock market, but the shares selected for inclusion in theindex are calculated to delete from the weighting shares of stocks thatdo not float on the stock market, such as shares which are closely heldby individual investors, the same or other corporations, foundations,endowments, trusts or governments. The initial populating of the stockindex may occur at any predefined current or past date. The number ofdifferent stocks in the stock index is preferably not fixed. Rather, thenumber of different stocks in the stock index may be determined by thenumber of stocks within the stock size range.

A second embodiment of the present invention provides anothercomputer-implemented method of creating and maintaining a stock index.Each stock in the index must meet a predefined criteria. To implementthe method, a predetermined time horizon is defined, and the timehorizon is divided into a plurality of time periods. For each new timeperiod, a packet of shares of stocks is selected for the index that meetthe predefined criteria. The shares of stock represented in the indexare defined as being the cumulative total of packets for the previouspredetermined time horizon. The time horizon may be one year and thetime period may be one month. If so, the cumulative total of packets forthe previous predetermined time horizon is the previous twelve monthlypackets.

A third embodiment of the present invention provides acomputer-implemented method of creating a growth stock index and a valuestock index for a universe of stocks. To implement the method, a firstset of criteria is defined for ranking stocks based on growth. A growthhurdle is selected for classifying the stocks as being growth stocksbased on the ranking. A second set of criteria is defined for rankingstocks based on value. A value hurdle is selected for classifying thestocks as being value stocks based on the ranking. A growth stock indexis created using the stocks that exceed the growth hurdle even if thestocks that exceed the growth hurdle also exceed the value hurdle. Avalue stock index is created using the stocks that exceed the valuehurdle even if the stocks that exceed the value hurdle also exceed thegrowth hurdle. Selected value and growth stocks may be present in boththe value and the growth indexes. For the stocks present in both thevalue and growth index, the sum of their shares represented in theseindexes does not need to sum up to the total shares represented in theuniverse of stocks. For example, for the stocks present in both thevalue and growth index, the sum of their shares may be twice the totalshares represented in the universe of stocks. The number of differentstocks in the stock index is preferably not fixed. Rather, the number ofdifferent stocks in the stock index may be determined by the number ofstocks that exceed the respective hurdles.

A fourth embodiment of the present invention provides acomputer-implemented method of creating a plurality of stock indexes fora universe of stocks. Each index has a different investment style. Toimplement the method, for each investment style, a set of criteria isdefined for ranking stocks based on the style (i.e., how closely doeseach stock match the set of criteria). A hurdle is selected forclassifying the stocks as being stocks having the style based on theranking. A stock index is then created for the style using the stocksthat exceed the hurdle even if the stocks that exceed the hurdle alsoexceed a hurdle for another style. Selected stocks may be present inmore than one investment style. For the stocks present in more than oneinvestment style, the sum of their shares does not need to sum up to thetotal shares represented in the universe of stocks. For example, for thestocks present in more than one investment style, the sum of theirshares may be at least twice the total shares represented in theuniverse of stocks. There may be more than two investment styles in thisembodiment. The number of different stocks in the stock index ispreferably not fixed. Rather, the number of different stocks in thestock index may be determined by the number of stocks that exceed therespective hurdles.

Additional embodiments of the present invention include differentcombinations and subcombinations of the four embodiments describedabove.

BRIEF DESCRIPTION OF THE DRAWINGS

The above summary, as well as the following detailed description of apreferred embodiment of the invention, will be better understood whenread in conjunction with the following drawings. For the purpose ofillustrating the invention, the drawings show embodiments that arepresently preferred. It should be understood that the invention is notlimited to the precise arrangements and instrumentalities shown. In thedrawings:

FIGS. 1A and 1B show a range of stocks included in market capitalizationindexes sorted by size, and illustrate the banding feature of thepresent invention;

FIG. 2 shows a two-dimensional view of growth and value and illustratesa stock selection feature of the present invention;

FIG. 3 shows a stock packetizing process in accordance with oneembodiment of the present invention;

FIGS. 4A-4H, taken together, provide a detailed flowchart for performingthe method; and

FIG. 5 shows a block diagram of one embodiment of a computer-implementedsystem which creates and maintains stock indexes.

DETAILED DESCRIPTION OF THE INVENTION

Certain terminology is used herein for convenience only and is not to betaken as a limitation on the present invention. In the drawings, thesame reference letters are employed for designating the same elementsthroughout the several figures.

1. Overview of Present Invention

It is possible to create and maintain indexes that are meaningfulbenchmarks for managers who follow specific investment styles (e.g.,growth or value), focus on stocks of a particular size (e.g., large-capor small-cap stocks), or look for some combination of thosecharacteristics. The starting point is this cardinal rule: An index mustreflect the way that money managers actually invest.

This rule may sound like circular reasoning—defining value as whatpeople call value. The reality, however, is that growth and value, andsmall-cap and large-cap, are what investment managers deem them to be.Modern portfolio theory doesn't define any of those terms. Investors andmanagers do. The indexes that track these sectors should incorporate thethought processes of these managers. The best index isn't necessarilythe one that provides the highest return; it is the one that mostaccurately measures the performance of the style that it is designed totrack.

The present invention provides a set of guidelines for the constructionand maintenance of ideal indexes. With better tools, investors will beable to make better decisions about how their money is managed. Theseguidelines are not intended to make the lives of index fund managerseasier. An index fund is a rational investment only if it provides analternative to active management in a low-cost, relatively tax-efficientway, or if it offers exposure to a segment of the market in which activemanagement is difficult, if not impossible. For instance, micro-capstocks are too illiquid to be managed actively in a portfolio with highturnover. Indexes designed only to simplify the lives of indexersprobably wouldn't meet these criteria. However, if the rules forcreating and maintaining indexes based on the behavior of activemanagers also simplify the indexers' job, so much the better.

The following five guidelines and rules are part of the index creationand maintenance process of the present invention.

A. Rely on Objective, not Subjective, Rules

An index can be rules-based and objectively maintained, with noambiguity about when a stock should be included or excluded.Alternatively, an index can be more subjectively reconstituted by anindividual or committee according to broad guidelines. Each approach haspros and cons.

A purely objective approach ensures absolute style integrity and totaltransparency, precluding debate about the merits of including one stockor another. However, it also can, but does not have to, result in shortbursts of high turnover, raising costs and tax inefficiency. Activemanagers, even those with high portfolio turnover, don't implement sixmonths' or a year's volume of portfolio adjustments on a single day.

On the other hand, a subjective approach to index maintenance may allowfor more orderly management of changes. This approach, however, issubject to committee decisions that do not precisely represent thedecision process of active management.

The most important characteristic of indexes tracking the market'ssubsectors—in essence, sectors created and defined by managers—should bethat they accurately reflect the thought processes of active management.For that reason, style integrity is extremely important, and anobjective set of rules for creating and maintaining an index ispreferable to the vagaries introduced by a subjective process.

B. Adjust Weightings for Cross-Holdings/Float

For the purposes of determining a company's size and capitalizationcategory, it is necessary to take into account all of a company'soutstanding shares, because the stock's performance is influenced by theeconomic size of the company. However, a different standard should beused in determining the stock's weight in an index.

The investment universe available to active investors should be thestarting point for determining individual stock weights for all indexes.Many companies have shares that are closely held by individualinvestors, the same or other corporations, foundations, endowments,trusts or governments, or stock pledged as collateral. To the extentthat these positions represent strategic long-term holdings that do not“float” on the market, they are not a part of active investors'opportunity set, and they should not be used to calculate the stock'sweight in the index, and thus its contribution to the index's return.Including these shares in a benchmark distorts its return relative tothe universe of active investors because, in aggregate, the managerscannot own all of the shares outstanding. In truth, there is probably noindex-related issue less debatable than this. In fact, two major globalindexes, the MSCI and FTSE indexes, have recently been reconstituted toadjust for shares that don't float. Although these changes resulted inhundreds of billions of dollars' worth of transactions for index andactive funds, causing large transaction costs, those short-term costswill improve the long-term integrity of the indexes.

C. Define Market Capitalization as a Band, not a Line in the Sand

Indexes based on market capitalization must be periodicallyreconstituted to ensure that they reflect the performance of the marketsegment they purport to measure. Both objectively and subjectivelydetermined indexes currently capture this concept, to varying degrees.In each case, the rebalancing usually results in significant marketimpact on the stocks affected and unnecessary turnover and transactioncosts. This marketplace turmoil is not prima facie evidence of poorindex construction. However, rebalancing as it is now practiced doesn'treflect how active managers adjust their portfolios, and, therefore,leads to the creation of an inappropriate benchmark.

Active managers do not unanimously agree on the boundaries between twocapitalization ranges. One manager might classify a company having a $4billion market capitalization as large-cap, while another might considerit mid-cap. To capture this ambiguity, an index's demarcation betweencapitalization ranges should be a band, not a line in the sand. If astock's' relative market capitalization changes so that it enters theband, the stock remains a constituent in the index to which it waspreviously assigned, if any. It migrates to the other index only if itexits the opposite side of the band. A small-capitalization stock willremain in the small-cap index even if its market cap grows into therange that may have demarcated “large-cap” when the index was firstestablished. It will become a large-cap stock only if its marketcapitalization moves past the upper edge of the small-cap band.

The advantages of these bands are twofold: First, they reduce turnoverduring periodic index rebalancings, as stocks would not vacillatebetween one index and another based on minor changes in their marketcapitalizations. Second, and more important, these bands more accuratelyreflect the way active managers think of their investment universe.Managers do not summarily throw a stock overboard because it crosses animaginary line. They frequently continue to hold it even though amanager with a different investment style might consider it to be in adifferent index classification.

Building the Bands and Defining Capitalization Ranges

The capitalization bands are preferably based on the relative sizes ofstocks (ordinal or percentile ranking), rather than on static dollarfigures that may or may not be appropriate as the market rises andfalls. For instance, the initial cutoff for a large-cap index may be the700^(th)-largest stock, as measured by total, as opposed tofloat-adjusted, market capitalization. Or it may be the stockrepresenting the 85th percentile of the stock market's capitalization.(These boundaries are just suggestions, but they are roughlyappropriate.)

The band around the large-capitalization cutoff may be plus or minus 150stocks, or plus or minus five percentage points of marketcapitalization. A stock previously classified as small- or mid-cap wouldbe added to the large-cap index once it became the 549th largest stock,or the stock representing the 79th percentile of cumulative marketcapitalization. Similarly, a stock would be removed from the large-capindex when it became the market's 851st largest stock, or the stockrepresenting the 91st percentile of cumulative market capitalization.

The small-cap index should be a complement of the large-cap index, withan initial cutoff of perhaps 700 for the largest stock and, as suggestedabove, 2,500 for the smallest stock. (The absence of a mid-cap indexseparating large and small caps may seem odd, but this constructionbetter reflects active managers' capitalization exposure.) The cutoffsshould be bounded by the 300-stock bands used in the large-cap index.While the top cutoff may seem high, it reflects the holdings ofsmall-cap managers. In fact, the performances of the Russell 2500 andWilshire 4500 Indexes—both of which include mid-caps and small-caps—moreclosely correlate to the performance of small-cap managers than doesthat of the strictly small-cap Russell 2000 Index. Stocks smaller thanthe 2,500th stock could comprise a microcap index (a segment for whichno index yet exists).

The mid-cap index may overlap the large-cap and small-cap indexes, withinitial break points at perhaps the 400th-largest stock at the top andthe 1,200th-largest stock at the bottom, with both cutoffs surroundedby, perhaps, 300-stock bands. FIG. 1A illustrates this conceptgenerically. The first column shows the total stock market. The secondcolumn shows the universe of large-cap stocks; the third, that ofsmall-cap stocks; and the fourth, that of midcap stocks. Thedashed/dotted lines show the initial cutoffs for the differentcapitalization ranges. The dashed lines show the bands, or hurdles, thata stock must cross in order to move from one capitalization range toanother. FIG. 1B illustrates this concept hypothetically in a graph thatuses the actual numbers described above.

Some investors may be concerned that, because the mid-cap index overlapsthe large- and small-cap indexes, the three together would not replicatethe total stock market. But overlap is a problem that investors alreadyface when combining two or more actively-managed funds, or even whencomplementing an active fund with an index fund. Active managers followno hard-coded rules about market capitalization. Two managers withdifferent mandates will frequently consider the same stock to be intheir target ranges. An investor who wants a total-market index isbetter off investing in one directly than trying to build one withsub-indexes.

D. Determine Style (or Other Characteristics) in Two or More Dimensions

Most widely accepted indexes consider value and growth stocks to becomplements of each other. By this definition, a growth stock isanything that is not a value stock, and a value stock is anything thatis not a growth stock. The delineation typically depends upon a singlefactor, such as price/book ratio, or perhaps a combination of severalfactors blended into a single style rank for every stock, as depicted inthe spectrum below:

Active managers do not believe their world is flat. A value manager mayhold a stock owned by a growth manager. The stock may fully satisfy therequirements of both. A value manager might require that a stock have alow price/earnings ratio, for example, but would certainly not bedismayed to see that it also enjoyed strong growth prospects. Nor woulda growth manager exclude a stock that met his or her requirements forgrowth just because it sported a low valuation.

Using their own independent criteria, value and growth managersoccasionally fish from the same pond. Conversely, some stocks areattractive to neither. For active managers, stocks don't fall into rankon a simple line like that shown above; instead, the delineation betweenvalue and growth is two-dimensional.

Value managers emphasize a company's fundamentals relative to itscurrent price, including price/earnings, price/book, price/sales anddividend/price (yield) ratios. They analyze companies based on thesecriteria and subject those that pass a certain hurdle to furtheranalysis. Growth managers, by contrast, place the primary emphasis oncharacteristics such as earnings growth, sales growth, and margingrowth. Working independently, value and growth managers analyzecompanies along their own growth or value spectra. Their combined viewis shown in the graphic of FIG. 2.

In two dimensions, some stocks are pure value or growth, others are bothvalue and growth, while still others appeal to neither growth nor valuemanagers. Based on a stock's price ratios, for example, a value managermight conclude that it is a value stock. Evaluating its sales andearnings growth, a growth manager might conclude that the same securityis a growth stock. Using two distinct methodologies, both managersdetermine that the stock is a component of their universe. Style-basedindexes should reflect this reality, rather than forcing a stock intoone category or the other. Consequently, growth and value indexes, assubsets of broader indexes, should not be perfect complements.

Given this design, a combination of value and growth indexes will resultin some overlap in holdings. It will also exclude some stocks. But thatis true of actively-managed portfolios as well. As in the case of marketcap-oriented funds, the combination of actively-managed growth and valuefunds does not yield a complete non-overlapping portfolio. If theinvestment style indexes are to be good benchmarks, they won'tnecessarily be perfect complements of each other. Index investors whowant to combine value and growth should simply invest in an index fundthat tracks a blended index.

This methodology further allows for creation of deep-value andaggressive-growth indexes by setting higher hurdles for those extremestyles. And as with the capitalization indexes, bands may be placedaround the growth and value demarcations.

The value/growth concept may also be extended to cover all styles inmultiple dimensions, as discussed in more detail below.

E. Manage Stock Migration

Although market-cap and style-oriented bands would reduce turnover andbetter reflect the way active managers respond to changes in stockcharacteristics, there would still be those hard lines in the sand atthe edges of a band. When a company crossed this edge, the stock wouldexit the index, and in the case of size indexes, migrate entirely fromone classification to another. Once again, this is not an accuraterepresentation of how active managers respond to secular shifts in thecharacteristics of a company. In reality, because managers actindependently, there is no one point, or even brief period, in whichthey collectively decide to eliminate a stock that is leaving theirinvestment style. One by one, they may act quickly, but as a group theyremove such stocks from their portfolios gradually.

How can an index be made to reflect this reality? One way is to dividethe index into a plurality of time periods in a time horizon, such as 12equally sized subcomponents, with each subcomponent associated with amonth of the year. If Stock A had a market capitalization (or afloat-adjusted market capitalization) of $12 billion, for example, eachof the 12 subcomponents would contain $1 billion of Stock A. Everymonth, the subcomponent associated with that month would be opened up,analyzed, and reconstituted.

FIG. 3 shows how this might look, using an imaginary set of indexesbeing reviewed in May 2002. The index sponsor has opened that month'ssubcomponent, which was established in May 2001, and analyzed the stocksto determine whether they still meet the index criteria. In May 2001,Stocks A, B, and C were large-cap, and Stock D small-cap. A year later,Stock C has migrated down to the small-cap category, and Stock D hasmigrated up to the large-cap category. The subcomponent's 1/12 positionin Stock C is moved to the small-cap index, and its 1/12 position in Dis moved to the large-cap index. Adjustments made in the Maysubcomponent have no effect on the other 11 subcomponents.

This process means that, during any one month, only 1/12 of a stock'sfloat-adjusted market capitalization would be transferred from one indexto another. At a minimum, it would take 12 months for a stock toentirely migrate from one index to another. During this transitionperiod, the stock might be in two or more indexes, but the weights inthe large- and small-cap indexes would be complementary. A particularstock might have 7/12ths of its weight in the large-cap index, forexample, and 5/12ths in small-cap (and 12/12ths in a mid-cap index).

This migration process more closely reflects how active managers invest.First, they do not, as a herd, pile into, or out of, a stock as itcrosses a certain threshold. Instead, they collectively wade into andout of a position. An index that followed the same process would notonly be a better benchmark, it would also benefit index fund investorsby significantly reducing turnover and allowing the portfolio to berepositioned in a more orderly fashion, significantly reducing thefund's transaction costs by use of the monthly reconstitutions. Theindex itself would have lower embedded transaction costs, which wouldenhance long-term results.

It should be noted that most indexes currently lead to significanttransaction costs when securities are added or subtracted. The cost ofstyle integrity is disproportionately high for small-cap indexes, whichhave recently had annual turnover as high as 70% to 80%.

Summary Overview of Present Invention

To create relevant benchmarks for actively-managed investments, theappropriate frame of reference should be the active managers themselves.It is these managers, not investment theory, that define growth andvalue, small-cap and large-cap. With indexes that mimic the thoughtprocesses of active managers, investors would have better tools forevaluating the performance of professional managers, helping them tomake smarter decisions about their portfolio allocation. Consultants andresearchers would also have better tools for attributing a portfolioperformance to the returns of different investment styles.

A widespread misconception is that indexing works in large caps, but notin sectors such as small caps. At times, this conclusion appears to besupported by the data. But the real lesson of the data is that managersare being measured with the wrong yardsticks. With better benchmarks,outperforming—or underperforming—an index would no longer be a matter ofholding stocks from a different universe. Performance would reflect thesuccess of a manager's stock selections within the appropriate universe.Although it is unlikely that large numbers of active managers couldboast of index-beating performance, even over short periods, thesebetter indexes could in fact be a boon to talented active managers.Their relative success could be attributed to skill, not dismissed as anartifact of faulty benchmark construction.

2. Detailed Description

The present invention provides a computer-implemented method forcreating and maintaining stock indexes using one or more of the rulesand techniques described above.

FIGS. 4A-4H, taken together, provide a self-explanatory detailedflowchart for performing the method in accordance with one embodiment ofthe present invention.

The Appendix below is self-explanatory pseudocode for one implementationof a software program that performs the method in accordance with theflowchart.

An algorithm for investment benchmarks in accordance with one embodimentof the present invention is as follows:

Create Total Investable Universe

Identify the top 40% of names, sorted by market capitalization for eachmonth. Exclude REITS, foreigns, units, indices, etc. Each month is aPACKET. Each packet is stable for 12 months. For any month, there is aJanuary packet, a February packet, a March packet, etc. If this is June,the January packet was created on January 31 and held stable for eachmonth.

For each month end, combine the 12 months' packets (sharesoutstanding/12) on that month to create that month's Universe.

Divide Total Market into Large, Medium and Small

Based on cumulative percent of market capitalization, divide TotalUniverse into Large, Medium and Small benchmarks. All stocks <=85% ofcumulative market cap go into a Large packet. Stocks from 85% to 100% ofcumulative market cap are in a Small packet. Stocks from 75% to 92% ofcumulative market cap make up the Mid packet.

Combine 12 months of packets (shares outstanding/12) to form large, midand small universes.

Value and Growth

Value is defined as the average of the ordinal ranks of Sales/Price,EBITD/Price, Book/Price, and Yield. This average is ordinally ranked forLarge, Medium and Small universes. A stock in two universes will havetwo different value ranks. Stocks with a value <=0.50 go into a packetautomatically. Stocks>0.5 and <=0.6, that were in the packet 12 monthsago stay in.

Combine the 12 packets to create the Value universe.

Growth is defined as 50% IBES Long-Term growth ordinal rank, 25% 5 yearSales Growth and 25% 5 year EPS Growth. Again, the average is ordinallyranked for each universe. Stocks <=0.55 go into a packet. Stocks from0.55 to 0.65 that were in the packet 12 months ago stay in.

Combine the 12 packets to create the Growth universe.

FIG. 5 shows a block diagram of one embodiment of a computer-implementedsystem which creates and maintains stock indexes. Stock data and thealgorithms for stock selection are input into a processor which createsthe indexes. The stock data may be obtained from any commerciallyavailable source. The processor may be any general-purpose computer.

Stock size is typically measured based on market capitalization.However, the stock size may alternatively be based on other factors,such as total sales of the company, total profits of the company, ortotal traded volume. The scope of the present invention includes ways tocharacterize a stock size, other than by market capitalization.

The guidelines and rules described above are equally applicable tosector indexes and country indexes.

The most common stock investment styles are value and growth. However,the scope of the present invention includes other types of investmentstyles, such as momentum or GARP (i.e., growth at a reasonable price).Thus, the investment style process may be multi-dimensional, allowingfor three or more different styles, while still allowing the same stockto overlap more than one style.

As discussed above, most conventional indexes do not allow a particularstock to fall within two different investment styles. However, someconventional indexes, such as the Russell 2000, allow a stock to spantwo investment styles, such as growth and value. When a stock spans twoinvestment styles, the combination of the weightings of the growth andvalue shares always sums up to the market segment. For example, if aparticular stock has half of the attributes of a growth stock and halfof the attributes of a value stock, the growth index will be weightedwith 50% of the stock, and the value index will be weighted with 50% ofthe stock. Other splits can be made, but the total will always equal100%. In the present invention, stocks which fall within a particularinvestment style are always weighted at 100%, regardless of whether thestock also falls within another investment style. The total weightingsthus need not sum up to the market segment.

Stated another way, the investment style feature of the presentinvention is unlike conventional definitions of style. The definition asdefined in the present invention allows for the sum to be greater orless than the parent. For example, the growth and value segments of theS&P and Russell indexes when combined always equal the value of theirrespective parent segments. Since in the definition of the presentinvention, a stock could be considered to be both fully exposed togrowth and to value, its full weight could appear in both stylesegments, and the combination of the two segments could contain twicethe weight of that stock relative to the parent segment.

Conventional indexes typically require a specific number of stocks to beincluded in the index. This process increases the amount of decisionsthat must be made by the index manager and/or committee, and addsanother layer of subjectivity to the index. The indexes created by thepresent invention do not have any requirements regarding the number ofstocks to include in the index. Once the criteria for the index is set,e.g., large-cap value stocks, then the number of stocks in the index isobjectively based on the number of stocks that meet the criteria at aparticular point in time. For example, a wave of mergers may increasethe number of stocks in a large-cap index, whereas a wave ofdivestitures may increase the number of stocks in a small-cap index.

The time that is selected to initially populate a stock index may causethe current constituents of the index to be slightly different. Thescope of the present invention is not limited to any particular rulesregarding the time for initial population. Since one goal of the presentinvention is to measure large, systematic factors in the stock market,the specific constituents of the index on any given time is notsignificant. The contribution of an individual stock to the index returntends to be overwhelmed by the systemic returns in the market.

Referring to the packet/systematic stock migration process, the timeperiods in which the time horizon is divided into may be fixed (e.g.,one month, semiannually, annually), or dynamic. Also, the time periodsneed not be equal. For example, stock activity is not constant all yearlong, and certain times in a year are historically more important thanothers, such as the end of the year or months that span fiscal quarters.It may be advantageous to divide the packets into unequal time periods.Dynamic time periods may be useful when specific countries havereporting conventions that group financial reporting into one or twoperiods. In such a case, it may be beneficial to have some time periodsof different length.

As discussed above, the packet of shares of stocks selected for each newtime period may be market cap weighted. However, the cumulative total ofpackets will not necessarily be exactly market cap weighted, but will berelatively close to being market cap weighted.

As discussed above, some active managers inherently do systematic stockmigration, but they do not employ any systematic, formulaic, andobjective approach to doing so, as set forth in the present invention.Applying systematic stock migration to indexes is both complicated andnot intuitive, and thus is not done today. Indexes, and the index fundsthat follow the index, are typically managed so as to always have aspecific list of stocks to be included, as well as a specific number ofstocks. Systematic stock migration requires partial weightings of stockfor stocks that are migrating into and out of the index. An index thatuses systematic stock migration also will not have a fixed number ofstocks, since the number of stocks that are in migration varies overtime.

The number of different stocks in the stock index is preferably notfixed. Rather the number of different stocks in the stock index may bedetermined by the number of stocks within the stock size range and/orthe number of stocks that meet a predetermined style. However, the scopeof the invention also includes embodiments wherein the number ofdifferent stocks in the stock index is fixed, but the other principlesof the present invention (e.g., banding, packetizing, stock selectionfor investment styles) are still applied. In this manner, the principlesof the present invention may be applied to conventional stock indices,such as the Standard & Poor's 500 Index and the Russell 3000 Index. If afixed number of stocks is to be used, the algorithm that accumulates thepackets would be slightly modified to make the number of stocksconstant.

The scope of the present invention includes any methods for creating andmaintaining stock indexes, regardless of how the stock indexes areultimately used. Once a stock index is created, it may be directly usedby a money manager to select stocks for a stock fund comprised of clientaccounts, or it may be used by an index provider to advise a moneymanager on the selection of stocks. These uses of a stock index, as wellas other potential uses of a stock index, are within the scope of thepresent invention.

Index funds have coexisted with actively managed funds for many years.Nonetheless, indexes and their respective funds have not adopted many ofthe highlighted practices of active funds. The very idea that indexesand their respective index funds should incorporate practices of activefunds is itself not intuitive and thus inventive. The present inventionprovides specific objective ways for an index, and a fund that tracks anindex, to incorporate such active fund practices, thereby providing thebest of both worlds, namely, the better practices of active funds andthe cost advantages and tax efficiency of indexes, and thus index funds.

The present invention may be implemented with any combination ofhardware and software. If implemented as a computer-implementedapparatus, the present invention is implemented using means forperforming all of the steps and functions described above.

The present invention may be implemented with any combination ofhardware and software. The present invention can be included in anarticle of manufacture (e.g., one or more computer program products)having, for instance, computer useable media. The media has embodiedtherein, for instance, computer readable program code means forproviding and facilitating the mechanisms of the present invention. Thearticle of manufacture can be included as part of a computer system orsold separately.

It will be appreciated by those skilled in the art that changes could bemade to the embodiments described above without departing from the broadinventive concept thereof. It is understood, therefore, that thisinvention is not limited to the particular embodiments disclosed, but itis intended to cover modifications within the spirit and scope of thepresent invention.

APPENDIX procedure benchmark_data_creation( )  while (this_date)  get_stocks( )   get_necessary_data( )   rank_stocks( market cap)   for(each defined market cap segment)      create_packet(market cap,low_rank, high_rank, lower_exit_rank,          upper_exit_rank,lower_entrance_rank, upper_entrance_rank )     move_packet_forward(this_date)      aggregate_packets(this_date)  end for   for (each market cap segment)    for (each defined style)      rank_stocks( style variable )      create_packet(style, low_rank,high_rank, lower_exit_rank,          upper_exit_rank,lower_entrance_rank, upper_entrance_rank )    move_packet_forward(this_date)     aggregate_packets(this_date)   end for   end for  end while end procedure procedure get_stocks ( ) for (all_stocks)   if (stock_meets_inclusion_criterion( ))   add stockto candidatelist  end for end procedure procedure get_necessary_data( ) for (all stocks)   get_market_capitalization( )  get_growth_and_value_score( )  end for end procedure procedurerank_stocks (variable)  sort stocks by variable ascending  for (eachstock)   assign rank  end for end procedure procedure create_packet(variable, low_rank, high_rank, lower_exit_rank, upper_exit_rank,         lower_entrance_rank, upper_entrance_rank) # low_rank : rankthat defines the lower boundary of the packet. For a segment thatincludes stocks from rank 100 to 200, this value = 100 # high_rank :rank that defines the upper boundary of the packet. For a segment thatincludes stocks from rank 100 to 200, this value = 200 # lower_exit_rank: defines the lower exit boundary for stocks leaving the packet. For asegment that includes stocks from rank 100 to 200, this value could =50. A stock that was in this packet last creation period would have tohave a rank < 50 to leave the packet # upper_exit_rank : defines theupper exit boundary for stocks leaving the packet. For a segment thatincludes stocks from rank 100 to 200, this value could = 250. A stockthat was in this packet last creation period would have to have a rank >250 to leave the packet # lower_entrance_rank : defines the lowerentrance boundary for stocks entering the packet. For a segment thatincludes stocks from rank 100 to 200, this value could = 150. A stockthat was not in this packet last creation period would have to have arank > 150 and a rank <= 200 to enter the packet # upper_entrance_rank :defines the upper entrance boundary for stocks entering the packet. Fora segment that includes stocks from rank 100 to 200, this value could =150. A stock that was not in this packet last creation period would haveto have a rank < 150 and a rank >= 100 to enter the packet  for (allstocks)   if (stock in last years segment packet) {    if (stockvariable > lower_exit_rank and stock < upper_exit_rank) add to segment  }   else {    if (stock variable > lower_entrance_rank and <=upper_rank) add to segment    if (stock variable < upper_entrance_rankand >= lower_rank) add to segment   }  end for end procedure proceduremove_packet_forward( this_date )  packet_number = month of (this_date) for (next 11 months from this date)   for (each stock)    split adjustshares from this_date to month end    drop stock if no longer pricing   save packet_number, stock, shares   end for  end for end procedureprocedure aggregate_packets(segment, this_date)  first_packet =month(this_date - 11 months)  this_packet = month(this_date)  for(first_packet to this_packet)   for (each stock)    sum shares from eachpacket   end for  end for  for (each stock)   divide shares by 12   savesegment  end for end procedure

1. A computer-implemented method of creating and maintaining a stockindex, the method comprising: (a) defining a stock size range, the sizerange having an upper limit and a lower limit; (b) defining a bandaround at least one of the upper limit and lower limit; (c) initiallypopulating the stock index with stocks that fall within the upper limitand the lower limit of the size range; (d) periodically adding stocks tothe index which fall within the stock size range and also fall outsideof the band; and (e) periodically deleting stocks from the index whichfall outside of the stock size range and also fall outside of the band.2. The method of claim 1 further comprising: (f) defining apredetermined time horizon; (g) dividing the time horizon into aplurality of time periods; (h) for each new time period, defining apacket of shares of stocks as being the stocks in the index asdetermined by steps (c)-(e); and (i) defining the shares of stockrepresented in the index as being the cumulative total of packets forthe previous predetermined time horizon.
 3. The method of claim 2wherein the time horizon is one year and the time period is one month,the cumulative total of packets for the previous predetermined timehorizon thereby being the previous twelve monthly packets.
 4. The methodof claim 2 wherein the time horizon is divided into an equal number oftime periods.
 5. The method of claim 2 wherein the time periods aredynamic.
 6. The method of claim 1 wherein the stocks that fall withinthe stock size range are determined without regard to whether shares ofthe stocks float on the stock market, the method further comprising: (f)weighting the shares that are selected for inclusion in the index todelete from the weighting shares of such stocks that do not float on thestock market.
 7. The method of claim 6 wherein the shares deleted instep (f) include shares which are closely held by individual investors,the same or other corporations, foundations, endowments, trusts orgovernments.
 8. The method of claim 1 wherein the stock size is based onmarket capitalization.
 9. The method of claim 1 wherein there are aplurality of consecutively defined stock size ranges, and the lowerlimit of the band of each stock size range is about equal to the upperlimit of the preceding stock size range.
 10. The method of claim 1wherein the initial populating of the stock index in step (c) may occurat any predefined current or past date.
 11. The method of claim 1wherein the number of different stocks in the stock index is not fixedand is determined by the number of stocks within the stock size range.12. The method of claim 1 wherein the number of different stocks in thestock index is fixed.
 13. The method of claim 1 wherein the band isdefined around the upper limit and the lower limit.
 14. The method ofclaim 1 wherein the stocks are added and deleted on a monthly basis. 15.A computer-implemented method of creating and maintaining a stock index,each stock in the index meeting predefined criteria, the methodcomprising: (a) defining a predetermined time horizon; (b) dividing thetime horizon into a plurality of time periods; (c) for each new timeperiod, selecting a packet of shares of stocks for the index that meetthe predefined criteria; and (d) defining the shares of stockrepresented in the index as being the cumulative total of packets forthe previous predetermined time horizon.
 16. The method of claim 15wherein the packet of shares of stocks selected for each new time periodis market capitalization weighted.
 17. The method of claim 16 whereinthe packet of shares of stocks selected for each new time period isweighted so as to delete from the weighting shares of stocks that do notfloat on the stock market.
 18. The method of claim 15 wherein the timehorizon is one year and the time period is one month, the cumulativetotal of packets for the previous predetermined time horizon therebybeing the previous twelve monthly packets.
 19. The method of claim 15wherein the selected packet of shares of stocks includes only stockswithin a defined stock size range based on market capitalization.
 20. Acomputer-implemented method of creating a growth stock index and a valuestock index for a universe of stocks, the method comprising: (a)defining a first set of criteria for ranking the stocks based on growth;(b) selecting a growth hurdle for classifying the stocks as being growthstocks based on the ranking; (c) defining a second set of criteria forranking the stocks based on value; (d) selecting a value hurdle forclassifying the stocks as being value stocks based on the ranking; (e)creating a growth stock index using the stocks that exceed the growthhurdle even if the stocks that exceed the growth hurdle also exceed thevalue hurdle; and (f) creating a value stock index using the stocks thatexceed the value index even if the stocks that exceed the value indexalso exceed the growth index, wherein selected value and growth stocksmay be present in both the value and the growth index, and for thestocks present in both the value and growth index, the sum of theirshares represented in the indexes does not need to sum up to the totalshares represented in the universe of stocks.
 21. The method of claim 20further comprising: (g) ranking the stocks based on relative stock size,and dividing the stocks into a plurality of stock size ranges, whereinsteps (e) and (f) are performed for each stock size range.
 22. Themethod of claim 21 wherein the stock size ranges are small, medium andlarge capitalization stocks.
 23. The method of claim 21 wherein eachstock size range has an upper limit and a lower limit, the methodfurther comprising for each stock size range: (h) defining a band aroundat least one of the upper limit and lower limit; (i) initiallypopulating the stock index with stocks that fall within the upper limitand the lower limit of the stock size range; (j) periodically addingstocks to the index which fall within the stock size range and also falloutside of the band; and (k) periodically deleting stocks from the indexwhich fall outside of the stock size range and also fall outside of theband.
 24. The method of claim 20 further comprising: (g) defining apredetermined time horizon; (h) dividing the time horizon into aplurality of time periods; (i) for each new time period, defining apacket of shares of stocks as being the stocks in the value index andthe growth index as determined by steps (a)-(f); and (j) defining theshares of stock represented in the value index and the growth index asbeing the cumulative total of packets for the previous predeterminedtime horizon.
 25. The method of claim 24 wherein the time horizon is oneyear and the time period is one month, the cumulative total of packetsfor the previous predetermined time horizon thereby being the previoustwelve monthly packets.
 26. The method of claim 20 wherein for thestocks present in both the value and growth index, the sum of theirshares is twice the total shares represented in the universe of stocks.27. The method of claim 20 wherein the number of different stocks in thestock index is not fixed and is determined by the number of stocks thatexceed the respective hurdles in steps (e) and (f).
 28. The method ofclaim 20 wherein the number of different stocks in the stock index isfixed.
 29. A computer-implemented method of creating a plurality ofstock indexes for a universe of stocks, each index having a differentinvestment style, for each investment style, the method comprising: (a)defining a set of criteria for ranking the stocks based on the style;(b) selecting a hurdle for classifying the stocks as being stocks havingthe style based on the ranking; and (c) creating a stock index for thestyle using the stocks that exceed the hurdle even if the stocks thatexceed the hurdle also exceed a hurdle for another style, whereinselected stocks may be present in more than one index, and for thestocks present in more than one index, the sum of their shares does notneed to sum up to the total shares represented in the universe ofstocks.
 30. The method of claim 29 further comprising: (d) defining apredetermined time horizon; (e) dividing the time horizon into aplurality of time periods; (f) for each new time period, defining apacket of shares of stocks as being the stocks in the index asdetermined by steps (a)-(c); and (g) defining the shares of stockrepresented in the index as being the cumulative total of packets forthe previous predetermined time horizon.
 31. The method of claim 30wherein the time horizon is one year and the time period is one month,the cumulative total of packets for the previous predetermined timehorizon thereby being the previous twelve monthly packets.
 32. Themethod of claim 30 wherein the time horizon is divided into an equalnumber of time periods.
 33. The method of claim 30 wherein the timeperiods are dynamic.
 34. The method of claim 29 wherein for the stockspresent in more than one investment style, the sum of their shares is atleast twice the total shares represented in the universe of stocks. 35.The method of claim 29 wherein there are more than two investmentstyles.
 36. The method of claim 29 wherein the number of differentstocks in the stock index is not fixed and is determined by the numberof stocks that exceed the hurdle in step (c).
 37. The method of claim 29wherein the number of different stocks in the stock index is fixed.